Impairment

Definition

Impairment is the diminishing of the value of an asset, specifically when the recoverable amount of a fixed asset or goodwill falls below its carrying amount. This reduction may result from various factors such as obsolescence, physical damage, or a decrease in market value. The accounting treatment and recognition of impairments are governed by specific standards.

Examples

Manufacturing Equipment: A machine used in a manufacturing plant that no longer performs efficiently and thus, cannot generate expected cash flows due to technological advancements causing it to be obsolete. An impairment loss should be recorded to reduce the carrying amount to its recoverable amount.
Real Estate Property: A commercial building that suffers from significant physical damage due to a natural disaster. The impairment would be recognized by comparing its carrying amount and the lowered recoverable amount post-disaster.
Goodwill: A business acquisition for which the expected future benefits have dropped significantly due to the loss of a major customer. The acquired goodwill would need impairment testing and potential write-down.

Frequently Asked Questions

Q1: How is impairment determined?
A1: Impairment is determined by conducting an impairment review, which assesses whether the carrying amount exceeds the recoverable amount of the asset. Recoverable amount is the higher of fair value less costs of disposal and its value in use (i.e., the present value of expected future cash flows).

Q2: What is a carrying amount?
A2: The carrying amount is the value at which an asset is recognized on the balance sheet after deducting any accumulated depreciation and impairment losses.

Q3: When should an impairment test be conducted?
A3: An impairment test should be conducted whenever there is an indication that an asset might be impaired. For goodwill and intangible assets with an indefinite useful life, an impairment test must be conducted at least annually.

Q4: What standards govern the accounting for impairments?
A4: The International Accounting Standard (IAS) 36, “Impairment of Assets”, and the International Financial Reporting Standard (IFRS) 5, “Disposal of Non-current Assets and Presentation of Discontinued Operations”, govern the accounting for impairments.

Recoverable Amount: The higher of an asset’s fair value less costs of disposal and its value in use.
Goodwill: An intangible asset that arises when a buyer acquires an existing business but pays more than the market value of its net identifiable assets.
Carrying Amount: The amount at which an asset is recognized in the balance sheet after deducting any accumulated depreciation and accumulated impairment losses.
Impairment Review: An analysis to determine whether an asset’s carrying amount exceeds its recoverable amount, thereby necessitating an impairment loss.
International Accounting Standard (IAS) 36: A standard prescribing the procedures that an entity should apply to ensure that its assets are not carried at more than their recoverable amount.
International Financial Reporting Standard (IFRS) 5: A standard that sets out the accounting treatment for assets held for sale and the presentation and disclosure of discontinued operations.

Online References to Further Resources

Suggested Books for Further Studies

“Wiley IFRS 2023: Interpretation and Application of IFRS Standards” by PKF International Ltd (Author).
“International GAAP 2022: Generally Accepted Accounting Practice under International Financial Reporting Standards” by Ernst & Young LLP.
“Impairment and Disposal of Long-Lived Assets: Comprehensive Guide to Financial Reporting” by Michael D. Fahy and Scott R. Hurtrez.
“Financial Reporting and Analysis” by Charles H. Gibson.

Accounting Basics: “Impairment” Fundamentals Quiz

### What triggers an impairment review? - [x] Indicators that the asset's carrying amount may not be recoverable. - [ ] A change in the depreciation method used for the asset. - [ ] The acquisition of a similar asset by a competitor. - [ ] An increase in the asset's market value. > **Explanation:** An impairment review is triggered when there are indicators that suggest the carrying amount of an asset may not be recoverable. ### What is the recoverable amount? - [ ] The initial cost of acquiring the asset. - [ ] The net book value recorded on the balance sheet. - [x] The higher of fair value less costs of disposal and value in use. - [ ] The amount the asset can be sold for at any time. > **Explanation:** Recoverable amount is defined as the higher of fair value less costs of disposal and the asset's value in use. ### What standard specifically addresses impairment of assets internationally? - [x] IAS 36 - [ ] GAAP - [ ] IAS 17 - [ ] ASC 842 > **Explanation:** Internationally, IAS 36 specifically addresses the impairment of assets. ### Which of the following assets should be tested annually for impairment? - [ ] All tangible fixed assets - [x] Goodwill and indefinite-life intangible assets - [ ] Depreciable assets like machinery - [ ] Land > **Explanation:** Goodwill and indefinite-life intangible assets are required to be tested for impairment at least annually. ### How is an impairment loss recognized in financial statements? - [ ] As a reduction in the asset's historical cost - [ ] As part of equity adjustments - [x] As an expense in the income statement - [ ] As a current liability > **Explanation:** An impairment loss is recognized as an expense in the income statement. ### What does "value in use" refer to in impairment calculations? - [ ] The replacement cost of the asset - [x] The present value of future cash flows generated by the asset - [ ] The book value of the asset after accounting for depreciation - [ ] The original purchase price of the asset > **Explanation:** Value in use refers to the present value of future cash flows expected to be derived from the asset. ### If an asset's carrying amount exceeds its recoverable amount, what must be recorded? - [x] An impairment loss - [ ] Depreciation expense - [ ] A valuation allowance - [ ] An unrealized gain > **Explanation:** If an asset's carrying amount exceeds its recoverable amount, an impairment loss must be recorded. ### What impacts the calculation of an asset's fair value less costs of disposal? - [ ] The accounting policies adopted by the entity - [ ] The asset's value in use - [ ] The current use of the asset within the business - [x] Market-based information such as sales prices of similar assets > **Explanation:** Fair value less costs of disposal is influenced by market-based information like sales prices of similar assets. ### Which financial statement reports the carrying amount of long-term assets? - [x] Balance Sheet - [ ] Income Statement - [ ] Statement of Cash Flows - [ ] Statement of Equity > **Explanation:** The balance sheet reports the carrying amount of long-term assets. ### What is a major factor that can lead to asset impairment? - [ ] Improvements in asset's technology - [x] Decline in market value of the asset - [ ] Revaluations that increase asset value - [ ] Higher depreciation expense > **Explanation:** A decline in the market value of an asset is a major factor that can lead to asset impairment.

Thank you for delving into the concept of impairment and challenging yourself with these quiz questions. Stay committed to advancing your accounting proficiency!